Updated: Jun 9, 2021
“Far from the madding Crowd’s ignoble Strife,
Their sober Wishes never learn’d to stray;
Along the cool sequester’d Vale of Life
They kept the noiseless Tenor of their Way”
Thomas Gray (1716-71)
June 8, 2021 | In this issue of The Institutional Risk Analyst, we survey the scene of “meme” investing, a fascinating phenomenon that reminds us that humans are anything but rational, especially when confronted with change. A meme, for those unfamiliar, is:
1 : an idea, behavior, style or usage that spreads from person to person within a culture. 2 : an amusing or interesting item or genre of items that is spread widely online especially through social media.
One of the downsides of the FOMC’s social engineering is that deflation in financial assets or prices more generally is never allowed to occur. This means that the portion of the market that is, to be polite, irrationally exuberant, is never purged from the system. There is no reset, no time out from the silliness, thus the speculative froth simply grows until it spills out of the glass. Fed Chairman Jay Powell effectively is short an equity put option to the world.
The narrative is the carrier of the meme, the river of absurdity and credulity that transmits the speculative virus to the broader population. As more and more people became aware of the get-rich potential of bitcoin or other crypto currencies, for example, the meme narrative expanded, spawning an army of true believers that will tolerate no disagreement with their faith.
The speculative madness is not limited to ethereal concepts like crypto currencies and the growing number of derivatives. Consider the meme icon and theater operator AMC Entertainment (NYSE:AMC), a recent high-flyer that has used the artificial environment provided by the FOMC to raise billions of dollars to support a business that seems headed for the dust heap of history.
As Michael Whalen discussed with The IRA back in 2017 (“The Economics of Content: Michael Whalen”), the world of film and video content is in the midst of a massive shift in terms of who holds the leverage on pricing. The pendulum is swinging back in the direction of artists and owners of content that are able to go direct to customers via social media.
Michael Whalen, who spends his days acquiring and curating legacy content for Cutting Edge Group, predicted a while back that the owners of legacy TV content would eventually pool their assets in desperation. And four years later, viola! The business of making and selling content for electronic artists is changing in ways that render conventional channels such as theaters as moribund as bookstores.
Many analysts and media have pointed out that AMC is a business with significant challenges once the appeal of going out again and free popcorn loses its luster. The leverage that was taken on during the COVID lockdown has now been refunded somewhat with a huge equity raise. But to what end?
Of course, AMC is an edifice of financial solidity compared with GameStop (NYSE:GME), the now infamous software retailer and meme icon that introduced many older Americans to the world of www.reddit.com. Once a haven for non-financial discussions, the Reddit community suddenly exploded into the world of investing. Simply, a group of day traders chatting on Reddit annihilated several hedge funds, pushing GME up to truly silly levels.
You could tell the Reddit kinder that GME is a dud, but it does not matter. We participate in some of the discussions regarding Rocket Companies (NYSE:RKT), which is after all just a mortgage company, albeit a really good one. But the vernacular used by the RKT fans cruising on Reddit ignores things like facts and industry analysis, in favor of a purely emotional narrative. “Going to the moon” is a representative sample of the Reddit discourse on RKT.
Even in the pedestrian world of financials, the narrative has raced ahead of reality and, in some cases, entirely in the opposite direction. Witness our old friends at Barron’s gently pumping already toppy bank stocks in this week’s issue with the prospect of loan growth? Hello? The names selected are solid performers, but generally speaking, loan growth has been trending down for years. The only way banks grow their portfolios is to buy loans originated by non-banks.
Fortunately Barron’s managed to mention Baird analyst David George, who argues rightly that any pickup in loan growth will be muted. “We continue to expect core loan growth will be soft near term as corporations utilize large cash buffers to fund working capital and capex needs before borrowing from banks.” Ditto David. And consumer loan growth is muted as well.
As we note in the most recent issue of The IRA Bank Book, loan portfolios are continuing to shrink even as the data from the Federal Reserve shows new lending growing. How can this be? Well, if you look at the stock of loans instead of merely the inflow, then you must also take note of loan redemptions or outflow as well as loan sales. Banks ended significant sales of credit card receivables years ago. That's a hint.
Net, net, banks are seeing redemptions of loans, thus the portfolio is shrinking in many categories. Notice two things. First banks are more buyers of loans than lenders. Second, sales of loans by banks have also plummeted, another sign that banks are seeing net runoff of loans. And this is not just about corporates. C&I loans did rise $200 billion in Q1 2021, but only after quarters of net runoff. Consumer credit utilization, of note, is falling in residential mortgage lending after a torrid 2020.
Notice that bank credit card balances started trending down in mid-2019. This is not about COVID, but changes in consumer behavior pre-COVID. Yet just about every investment manager and generalist reporter on the planet somehow manages to relate the prospect for bank loan growth with recovery from the COVID lockdowns.
Now it is interesting to note that the folks at Baird, who do know a few things about banks, recently changed their view of Capital One Financial (NYSE:COF), citing the high market valuation. The price of COF has tripled since March 2020. But to be fair, the $420 billion asset COF is an inconsistent performer that shows volatility in asset and equity returns vs Peer Group One. Given the heightened risk, COF is no bargain at 1.2x book.
Source: Yahoo Finance
George downgraded the bank to neutral from outperform and has a $145 price target, $20 below the current market. The consensus price objective is higher at $166.87, an unusual example of a Sell Side analyst rejecting the narrative of rising bank stock valuations.
As we’ve note previously, when you see high-risk names like COF, Citigroup (NYSE:C) and Goldman Sachs (NYSE:GS) trading above book value, then it’s time to take your money off the table and play with the house’s chips.
Pointing out that a subprime monoline credit card lender with a proclivity for screwing up efforts to diversify into new areas should not be trading at a premium might seem overly negative in the world of meme investing. Don’t be a hater, say the kiddies on Reddit or the crypto surfers on Twitter. Be happy.
Take a final example. Nouvelle mortgage lender Better.com, after unsuccessfully seeking an IPO, finally agreed to be acquired by a SPAC at the end of this year. The projected $7.8 billion valuation is, well, silly. Why? Because Better.com is simply a mortgage company with a slick web site. Also, Better.com raised money from the notorious Softbank of Japan.
Softbank and several funds have committed to invest in Better.com post close to goose the (valuation) growth even further. Once upon a time, such behavior was called securities fraud. We note that Swiss banks are currently shunning Softbank because of the mounting cost of the Greensill fraud, the Financial Times reports. Softbank was a key investor in that fiasco as well as the Wirecard fraud in Germany, of note.
In addition, the prospect of a close for Better.com in Q4 ’21 may be a challenge since many US residential lenders will be unprofitable by the end of the year. Secondary spreads could be inside 40bps, we are told. Even with the FOMC sucking tens of billions in MBS into the SOMA each week, we could see valuations in the mortgage complex give ground between now and December.
Q: What do you suppose will happen if the FOMC stops buying MBS, leaving the market to only private investors who are not indifferent to prepayments? Hmm?
As with RKT, Better.com is just a mortgage company that runs the same CFPB-compliant servicing systems as other firms, has the same awesome people, and is 100% correlated to interest rates and employment, period. We won’t know if the puffery about a better way to make and service mortgages works until the eventual market reset. In the meantime, just remember that manufacturing a residential mortgage purchase loan costs 2-3x that of a refinance loan.
It’s all about confidence you understand, whether we talk of markets or politics. But an investing world that is a function of confidence rather than earnings can only end in tears. When the illusion of confidence ebbs, then investors will run back to cash flow, as is currently the case with fund flows out of stocks and into bonds.
Meanwhile, the FOMC is madly trying to sop up excess liquidity via reverse repurchase agreements even as it adds more liquidity via QE bond purchases for the system open market account. “The heavy use of the [overnight] RRP facility tells us that foreign banks too are now chock-full of reserves,” warns former Fed staffer Zoltan Pozsar. Reserves will earn little return.
As we have noted more than once in The Institutional Risk Analyst, once you as the central bank go down the dark road of QE, you cannot stop buying assets and you cannot go back to square one. Add the reality of sudden, massive changes in fiscal spending and the logic of FOMC fine tuning breaks down entirely. The Fed did half a trillion dollars in reverse RRPs at the end of May. What about this week?
In the strange new world engineered by the FOMC via quantitative easing, facts do not matter. Valuations do not matter. All that matters is confidence in ever inflating asset valuations c/o the Federal Reserve Board. For now, just do like Softbank, Elon Musk et al and keep throwing money at a given asset class like Bitcoin until the price goes up.
In the world of meme investing, the assumption is inflated prices forever – until the Great Asset Price correction finally arrives. And in the event, don't forget, we shall all be so surprised. To this point, Anna Della Subin writes in The New York Review of Books:
“What do we learn of a world seen only through its illusions? Hoaxes, whether modern or ancient, tend to act as mirrors for the greater confidence games around us, from the claims to power of politicians and kings to the self-righteousness of those who assert they have a greater access to God.”